When it comes to investing, there are typically two main approaches: standard and alternative investments. Traditional assets, such as stocks, bonds, and mutual funds, have long been the foundation of many portfolios, providing stability and predictable returns. Alternative investments, such as real estate, private equity, hedge funds, and cryptocurrencies, can provide diversification and potentially higher returns, but they are also associated with additional risk and complexity. Understanding the distinctions between these two types of investments is essential for constructing a balanced and robust portfolio.
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Alternative Investments Overview
Alternative investments are those that do not match these traditional assets. These include:
- Property: Real estate that can produce income from rent or capital graphs.
- Private Equity: Investments in private equity companies — not traded on public stock exchanges, typically carrying higher risk and return.
- Hedge Funds: Pooled investments that attempt to achieve above-average returns for their investors through the use of tactics like leverage and derivatives.
- What Are Cryptocurrencies — Digital or virtual currencies that employ cryptology for security and work independently of a central bank.
Alternative investments can have the potential for higher returns and more diversification. However, they also involve a higher degree of risk than compared to other options we discussed here with lower liquidity and complexity in managing them. This is likely to be the case for some of these investments, and it might require more specialized knowledge since we are typically dealing with.
Traditional Investments Overview
Many of us are familiar with traditional investments. These include:
- Stocks: These are ownership shares in a company that gives the investor a stake in said business’ growth and profits.
- Bonds: Debt that allows you to lend money (a bond) to an institution such as a government or company and receive periodic interest payments, along with the repayment of your loan at maturity.
- Mutual Funds: An investment product made up by pooling funds from multiple investors to invest in a diverse portfolio of stocks, bonds, or other securities.
Traditional investments are — typically viewed as far safer and consistently keep pace when diversified. Public markets: Public company shares are typically liquid (can be easily bought and sold), with government oversight to protect investors.
Are alternative investments safe?
Alternative investments are thought to be safer than market-linked options like equities and mutual funds, but riskier than India’s preferred investment tools, such as gold and fixed deposit.
They are subject to many risks, including market, credit, and liquidity hazards. Let us examine these hazards and determine how safe alternative investment tools are for investing.
Market risk is the possibility of losing money on financial investments as a result of negative market movements or changing economic conditions such as a demand-supply imbalance, increased competition, and so on. They are related to alternative investments such as private equity, commodities, and so on that do not have fixed returns.
Related Post: A 10-Step Guide to Investing in Real Estate
Credit risk refers to a company’s inability to repay debt due to constrained cash flows. In worst-case scenarios, lenders’ entire investment may be nil.
Liquidity risk is a company’s inability to transform its assets into cash when needed. Alternative investments are highly illiquid and need a lock-in period before investors can withdraw funds.
The term “interest rate risk” refers to the possible loss of investment return as interest rates change. For example, you may have acquired a fixed-income investment at x% for five years; but, the current interest rate on new purchases may be (x+y)%, depending on the Reserve Bank of India’s monetary policy. Because alternative investments are inherently illiquid, you will lose an additional y% return for the remainder of your investment.
Default risk (also known as probability of default or PD) refers to the borrower’s failure to comply with the loan agreement’s obligations.
What’s the difference between traditional and alternative investments?
| Characteristic | Traditional Investments | Alternative Investments |
| Scope of Investment | Limited to regulated, public market securities (mainly stocks and debt/credit products). | Greater selection of private market assets, including private equity, private debt/credit, venture capital, buyouts, distressed enterprises, infrastructure, and real estate. |
| Liquidity | High liquidity offered by formal secondary market exchanges. | Very low liquidity for private assets. Moonfare provides limited secondary market opportunities for fund shares. |
| Minimum Commitment | There are effectively no investment minimums. | Minimums can be as high as USD10 million. (However, organizations such as Moonfare are also offering fund shares with minimums as low as €50,000). |
| Volatility | Valued daily. | Valued quarterly. |
| Transparency | High transparency (in compliance with public disclosure rules, including complete quarterly financial statements). | Low transparency (Investors are normally provided with quarterly disclosures, but the timing and detail may be at the discretion of the firm or fund management). |
| Investors | Open to any investment. | Limited to eligible investors only. |
| Time Horizon | Open-ended (Can be exchanged or retained for an infinite time span). | Generally regarded as medium-to-long-term investments due to frequent time spans of 10-12 years. |
| Examples | Public business common and preferred stocks, corporate and government bonds, mutual funds, and ETFs. | Private equity funds, private credit and debt funds, venture capital funds, buyout funds, distressed debt funds, and infrastructure funds. |
| Historical Returns since 2000³ (US PE Index against S&P 500 Index) | 5.91% | 10.48% |
Conclusion: The Art of Balance
There are advantages and disadvantages to both traditional and alternative investing. The idea is not to pit one against the other, but to recognize their unique capabilities and mix them in a way that meets individual goals and risk tolerances.
Historically, the purchase of alternative investments was typically limited to financially savvy investors such as institutions or high-net-worth individuals with prior knowledge or expertise, because alternative investments are not traded on financial markets and thus are not as accessible and liquid as traditional investment options.
Fortunately, alternative asset classes are now available to all investors; for example, Timeless allows you to participate in the performance of unique collectibles for as little as €50 per fraction. This way, you can avoid volatile market conditions while securing your gains.